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The Effectiveness of Interest Rates

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The rate of interest is historically considered as one of the most dependable of all monetary policy measures. However, at times when this measure could not be implemented, there are rooms for utilizing other measures to stimulate financial position as well, though the degree of their effectiveness is quite questionable. The authenticity of such actions could be verified from the following aggregate income identity, Y ≡ C (Y – T) + I (r) + G + X (e, Y) – M Where, Y ≡ Aggregate Output, C ≡ Aggregate I ≡ Aggregate investment, G ≡ Aggregate government expenditure, X ≡ Aggregate exports, M ≡ Aggregate imports, r ≡ Rate of interest and e = Rate of exchange From the above identity, the factors which are independent of aggregate output and rate of interest could be realized and those are the very factors which could be utilized to inject inflation within the economy.   The national government could instigate the aggregate economic output through injecting the lumpsum amount of money within the nation, since government expenditures, G, hardly depend the rates of interest and is rather considered as an exogenous factor.

In case of an open economy, there are also chances of increasing the contribution of trade balance (X - M) within the nation, by lowering the rate of exchange. However the problem, in this case, is that the export revenues might not change as dramatically as expected in theory. Hence, the net economic position might not alter much. The tax rates might also be reduced so as to stimulate the consumption levels through rising in the amount disposable income.

Thus, there are two effective measures that the national government could adopt – firstly, increase the amount of government expenditure and secondly, lower the tax rates. A point to be noted in this case is that the substitute policy measures are primarily fiscal in nature since monetary policy tools work via fluctuations in the rate of interest, which is inert in a liquidity trap situation.

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preview essay on The Effectiveness of Interest Rates
  • Pages: 9 (2250 words)
  • Document Type: Essay
  • Subject: Management
  • Level: Undergraduate
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